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Governor Corzine has asked us to provide you with a copy of the attached background paper on the pension payment deferral proposal.

While we may disagree with some of the points listed in this piece, we recognize the accuracy of his central point.

“Absent this temporary deferral, some communities would have to raise local taxes to unbearably high levels at the precisely wrong time, or make unacceptable sacrifices to the public in the delivery of critical municipal services in such areas as public safety, public health and education.”

Backgrounder on Proposal for Temporary Deferral of Local Pension Contributions

The Corzine Administration and local employers are working to maintain the solvency of the state’s pension system:

Municipalities have paid more into the fund since the phase in began earlier this decade than they had in the previous 12 years.

Legislative reforms to the pension and health benefit systems enacted over the last two years will save taxpayers $6.5 billion over the next 12 years, including $1.6 billion in savings to local government.

The proposal is designed as a way through the national economic crisis; giving local governments a tool to avoid higher property taxes and potentially damaging cutbacks in public safety and other vital services during the crisis:

Like State government, local governments are also suffering from the fiscally draining effects of this downturn.

Municipal, county and school budgets must comply with the 4% levy cap, which must be firmly enforced to protect property taxpayers.

Restructuring pension payments over a four-year period – and exempting the annual increases beyond 4% from the levy cap -- will go a long way toward easing the pressure on municipal, county and school budgets.

Equally important, the deferral would ease the property tax burden on New Jersey residents, many of whom are already financially overwhelmed by the economic crisis.

Absent this temporary deferral, some communities would have to raise local taxes to unbearably high levels at the precisely wrong time, or make unacceptable sacrifices to the public in the delivery of critical municipal services in such areas as public safety, public health and education.

With the absence of other solutions, this proposal helps to support service delivery, control property tax levies and minimize the impact on the pension system while providing an alternative investment option for those communities that have a less severe problem than others.

The basics of the proposal and options for local governments:

All local employers will pay 50% of the full pension contribution amount in State Fiscal Year 2009, 60% of the full pension contribution amount in SFY 2010, 80% of the full pension contribution amount in SFY 2011, and 100% of the full pension contribution amount in SFY 2012.

This proposal offers $585 million of immediate combined property tax relief to municipalities, counties, schools and local authorities over what would otherwise be required in payments this spring.

The proposal assists local governments that have already prepared to budget for the full contribution due in April or that intend to put aside funds to pay the deferred pension contributions. The State would create the option of a special investment fund – a separate reserve fund that would be invested by the Division of Investments in a way that mirrors the investments of the pension portfolio as a whole, but recognizing the shorter term of the separate reserve fund. This is NOT an option to make the required contribution to the pension system and to “opt” out of this deferral. It is only an option to set funds aside in a separate investment account.

This special reserve fund will accept deposits from local governments that are in excess of the phased-in pension payments over the next four years. The deposits will be invested and local governments would then be able to draw upon those invested funds to make any required pension contributions during the phase-in period. The funds and interest earnings belong to the local government agency – the state cannot use them for any reason.

This draw-down would make it possible for towns, counties and schools to create a dedicated reserve that can only be used for pension payments.

Local governments also would be able to create a similar, local reserve by investing reserved funds in the State Cash Management Fund or in any interest bearing account as permitted by the local government’s own cash management plan.

Q and A on Local Pension Contribution Deferral

Why is the State offering another “pension holiday”?

This is not a “pension holiday” but rather a temporary deferral of contributions. Unlike previous initiatives that allowed local governments and the State to fully skip regular contributions to the pension system, this proposal still requires substantial annual payments. It is also important to note that previous “holidays” occurred when the economy was strong. This proposal is only being offered because the economic crisis has greatly diminished the financial position of many local governments and New Jersey citizens. And like restructuring a mortgage during difficult times, this proposal is intended to ease a payment burden while giving financial conditions some time to improve. We also expect that recently enacted pension reforms will begin to take hold and generate system-wide savings over the deferral period.

What is the cost of this deferral of full pension contributions? Won’t this proposal generate a huge increase in the local liability once the 100 percent contribution resumes in 2012?

While the proposal would add to the unfunded liability the true cost, if any, cannot be predicted due to the wide variety of factors that affect the calculation of the unfunded liability. These factors affect New Jersey’s and all other defined benefit pension systems. For example, since cash contributions are invested and investment earnings help to meet liability expenses, the true “cost” of the deferral in addition to the potential increase of the unfunded liability would be what full contributions, if made, would otherwise generate to the pension fund from investment earnings.

Won’t this deferral still add to local governments’ huge unfunded pension liability?

Local employers’ pension liability is about one-third of the overall unfunded liability of the pension system. Primarily because local governments have been making substantial contributions to the system over the last five years, the funded ratio of the local funds is better than that of the state funds. As of June 30, 2007, the total unfunded liability of the system was $28.4 billion, with an overall funded ratio of 76%. Of that amount, only $4.1 billion is attributable to the local PERS and $5.1 billion to the local PFRS and the aggregate funded ratio for the locals is 80.3%.

Since the assumed rate of return for the pension system is 8.25 percent, isn’t this deferral essentially a three year “loan” at 8.25 percent?

No. The deferred amount of contributions becomes part of the other unfunded liabilities in the pension system. The unfunded liabilities of the system are amortized over 30 years, currently at the rate of 8.25 percent. The size of the liability-- and amortization -- are re-set every year by the state’s actuary, and the amount fluctuates after pension fund returns are factored in and system liabilities for members’ benefits earned are recalculated. So, the actual “cost,” if any, won’t be determined until long-term investment returns unfold over the next three decades.

If a portion of the full contribution is placed in the special reserve fund, how much will it earn?

As with pension fund investments today, there would be no guaranteed rate of return for the special reserve fund. The management of the special reserve fund would mirror that of the pension fund, but recognizing the special reserve fund’s shorter term. This would make the special reserve fund’s return comparable to that of the pension fund. If a local government wants to set aside funds, but does not want to use the special reserve fund, the local government can invest the funds in their normally permitted options. While the principal would not be at risk, the investment returns may be lower.

Why can’t the state allow for a true opt-out of this plan, giving local governments the option to make a partial or full contribution to the pension system?

This option would require legislation that would allow the New Jersey Division of Pensions and Benefits to create an accounting system model that establishes separate accounts for each and every local employer. By creating this system, the financial reporting responsibilities for pension contributions and liabilities would shift from the state to individual local employers. As such, we believe the recognition of pension obligations as debt would also shift from the state’s books to local governments’ books. This shift could add new financial reporting costs to local governments, and would also be factored into how bond rating agencies view a town’s fiscal position.